Tails Drive Everything
A small number of events account for the majority of outcomes
Long tails -- the farthest ends of a distribution of outcomes -- have tremendous influence in finance, where a small number of events can account for the majority of outcomes. Anything that is huge, profitable, famous, or influential is the result of a tail event -- an outlying one-in-thousands or millions event. In venture capital, out of 21,000 financings studied, 65% lost money, but 2.5% of investments made 10x-plus and drove the vast majority of returns. The same pattern holds for public stocks, business strategy, and creative work. When you accept that tails drive everything, you realize it's normal for lots of things to go wrong, break, fail, and fall. If you're a good stock picker you'll be right maybe half the time. If you're a good business developer maybe half your product ideas will work. Amazon, Apple, and Netflix's successes are all driven by tail products within companies that experimented with hundreds of failures. The key insight: you can be wrong half the time and still make a fortune.
- A small number of tail events account for the majority of outcomes in finance, business, and investing
- It's normal and expected for most things to fail -- even within highly successful portfolios and careers
- You can be wrong a lot and still make a fortune if your winners are big enough
- Anything huge, profitable, famous, or influential is almost certainly the result of a tail event
- We only see finished products, not the universe of failures that preceded the tail success
- Accept that most of your bets will failReframe your expectations around the statistical reality that even the best investors, entrepreneurs, and creatives are wrong more often than they're right. What matters is not your hit rate but the magnitude of your hits relative to your misses.Pro tipGeorge Soros once said he was right on barely more than half his trades. What made him successful was making a lot on the ones he got right and minimizing losses on the ones he got wrong. Tails drive everything.WarningThis is not permission for recklessness. Each individual bet should still be thoughtful -- the point is to tolerate failure, not to seek it.
- Structure for tail captureDesign your portfolio, career, and creative process to maximize exposure to potential tail events. This means diversification in investing, experimentation in business, and volume in creative work. You need enough at-bats for the tails to show up.Pro tipAmazon's strategy explicitly builds in failure tolerance. Jeff Bezos has said that Amazon's job is to try and fail, that they are the best place in the world to fail. This posture enables tail capture.WarningEnsure each individual experiment or bet is sized so that its failure doesn't take you out of the game. Room for error is the prerequisite for tail-hunting.
- Judge results by the portfolio, not the individual betEvaluate your overall results across all bets, not any single outcome. A venture fund that loses money on 65% of deals but returns 10x on 2.5% can be spectacularly successful. Apply the same portfolio thinking to your career, business strategy, and creative output.Pro tipChris Rock tests new material in tiny clubs, thumbing through notes and fumbling with jokes before refining them for Netflix specials. The polished final product is the tail that survived from hundreds of attempts nobody saw.WarningDon't extrapolate from individual failures. A single bad outcome tells you almost nothing about the quality of your overall strategy.
- Review and adjust periodicallyRevisit your approach regularly to ensure it still aligns with your circumstances, goals, and emotional tolerance. What was reasonable or appropriate at one stage of life may need updating as your situation evolves.Pro tipSchedule a quarterly review to check whether your financial behavior matches your stated principles.
Out of 25,300 stocks listed since 1926, the entire gain of the U.S. stock market was driven by just 1,000 companies -- 4% of the total. The other 96% collectively matched Treasury bills.
Amazon's growth is almost entirely due to Prime and Amazon Web Services. The company experimented with hundreds of products including the Fire Phone and travel agencies, most of which failed.
Among 21,000 venture financings from 2004 to 2014, 65% lost money. Only 2.5% made 10-20x returns, 1% made more than 20x, and 0.5% made 50x-plus.
Housel cites a study by Hendrik Bessembinder of Arizona State University showing that out of 25,300 publicly listed stocks since 1926, the entire gain of the U.S. stock market was attributable to just 1,000 companies -- 4% of the total. The other 96% collectively matched Treasury bills. He also draws from Correlation Ventures' analysis of 21,000 venture financings where 65% lost money, 2.5% made 10-20x returns, 1% made more than 20x, and 0.5% made 50x-plus. These tiny percentages drove virtually all the industry's returns. Even within successful companies, tails dominate: Amazon's growth is almost entirely due to Prime and AWS -- tail products from a company that tried and failed with the Fire Phone, travel agencies, and hundreds of other experiments.